B6 - Financial Risk Management

Question 1

Annual Percentage Rate

Answer 1

Effective Periodic Rate * Compounding periods

OR

Annual interest paid / Net Proceeds (if annual pay)

Noncompounded version of the effective APR

Required for disclosure

Emphasizes amount paid relative to funds available

Question 2

APR Example

Answer 2

Interest Paid $10,000*8%*6/12 $400

Divided by available funds ($10,000-$75-$50) $9,875

Effective Periodic Interest Rate 4.05%

Multiply by the # of compounding periods in a year (2)

Annual Percentage Rate 8.10%

Question 3

Effective Annual Percentage Rate abbreviated APR

Answer 3

Adjusted for the number of compounding periods per year.

(1+Effective Periodic Rate) ^ # of comp. periods -1

Effecrive Periodic Rate = Stated Rate / comp. period

Question 4

Simple Interest

Answer 4

= Total interest paid over life of loan

= principle * annual rate * # of years

Interes paid only on the original amount of principle w/o regard to comp.

Question 5

Compound Interest

Answer 5

Original principle plus any UNPAID interest earnings or expense

Maturity value for a 2 year, 8%, $10,000 note

= $10,000 * (1+8%)^2

= $10,000 * (1.1664)

= $11,664

Question 6

Maturity Risk Premium (MRP)

Inflation Premium (IP)

Liquidity Risk Premium (LP)

Default Risk Premium (DRP)

Answer 6

MRP = interest rate risk

IP = Purchasing Power Risk

LP = short sell at discount

Question 7

Factors influencing exchange rates

Answer 7

Trade Factor

• Relative inflation
• Relative income level (中国人有钱了来美国需要买美金，人民币相对美金反而贬值）
• Government controls

Financial Factor

• Relative interest rates and capital flows

Question 8

3 Types of Exchange Rate Risk

Answer 8

Transaction Exposure - econ. loss or gain upon settlement of individual transaction

Economic Exposure - potential that pv of an organization’s cash flows could increase or decrease as a result of changes in the exchange rates. Defined through local currency appreciation or depreciation.

Translation Exposure - Risk that asset, liabilities, equity or income of a consolidated organization that includes foreign subsidiaries will change as a result of change in exchange rate.

Question 9

Futures Hedge

Answer 9

Denominated in standard amounts and tend to be used for smaller transactions.

Contract can buy or sell at locked price.

Question 10

Forward Hedge

Answer 10

Similar to futures but are contracts between business and commercial banks and normally are larger.

Anticipate not just one transaction, but the entire organization’s need.

Question 11

Money Market Hedge

Answer 11

Uses intl markets to plan to meet future currency requirements.

Uses domestic currency to purchase a foreign currrency at current spot rates and invest them in securities timed to mature at the same time as related payables.

人民币换成美元再定存30天（AP matures）。

Question 12

Money Market Hedge (Borrowed Funds)

Answer 12

Borrow money domestically and invest them internationally to satisfy the payable denominated in a foreign currency.

Question 13

Money Market Hedget (Receivables)

Answer 13

Borrow money from foreign bank now (discounted AR) and convert that to domestic currency to satisfy cash needs. When AR is collected (full amount) pay back the bank using money collected.

Question 14

Working Capital Financing

Answer 14

Spontaneous financing of current assets with trade accounts payables and accrued liabilites

Question 15

Line of Credit

Answer 15

• Renewable annually
• Bank Loan
• I.E. Borrow money in October to stock up on inventory for sale in November and December